Money, Banking, and Monetary Policy ❮ 157Historically, the velocity of money in the United States has been fairly constant and
stable, so the increase in M must result in changes in either P or Q. Economists believe that
the quantity of output produced in a given year is a function of technology and the supply
of resources, rather than the quantity of money circulating in the economy. Therefore, the
increased money supply is going to only create a higher price level—inflation.
• The quantity theory of money predicts that any increase in the money supply only causes
an increase in the price level.❯ Review Questions
- Which function of money best defines $1.25 as
the price of a 20-ounce bottle of pop?
(A) Medium of exchange
(B) Unit of account
(C) Store of value
(D) Transfer of ownership
(E) Fiat money - If a bank has $500 in checking deposits and
the bank is required to reserve $50, what is the
reserve ratio? How much does the bank have in
excess reserves?
(A) 10 percent, $450 in excess reserves
(B) 90 percent, $50 in excess reserves
(C) 90 percent, $450 in excess reserves
(D) 10 percent, $50 in excess reserves
(E) 10 percent, $500 in excess reserves - Which of the following is a way that the Fed can
increase the money supply?
(A) An increase in the discount rate
(B) An open market operation that increases the
fed funds rate.
(C) An increase in the reserve ratio
(D) A decrease in tax rates
(E) Buying Treasury securities from commercial
banks - If the money supply increases, what happens in
the money market (assuming money demand is
downward sloping)?
(A) The nominal interest rates rises.
(B) The nominal interest rates falls.
(C) The nominal interest rate does not change.
(D) Transaction demand for money falls.
(E) Transaction demand for money rises.
5. To move the economy closer to full employment,
the central bank decides that the federal funds
rate must be increased. The appropriate open
market operation is to __, which __
the money supply, __ aggregate demand,
and fights __.
MONEY
OMO SUPPLY AD TO FIGHT
(A) Buy bonds Increases Increase Unem-
ployment
(B) Buy bonds Increases Increase Inflation
(C) Sell bonds Decreases Decrease Unem-
ployment
(D) Sell bonds Decreases Increase Inflation
(E) Sell bonds Decreases Decrease Inflation- Which of the following is a likely result of expan-
sionary monetary policy in a recession?
(A) Decreases aggregate demand so that the price
level falls.
(B) Increases aggregate demand, which increases
real GDP and increases employment.
(C) Increases unemployment, but low prices
negate this effect.
(D) It keeps interest rates high, which attracts
foreign investment.
(E) It boosts the value of the dollar in foreign
currency markets.